10 Tax Strategies for S Corps

The end of the year is fast approaching. If you’re an S corp owner, this means it’s time to get serious about minimizing your tax liability. Using smart tax strategies lets you keep more money in your business while staying compliant with IRS rules.

Let’s examine ten strategies to reduce your S corporation’s tax bill significantly.

What is an S Corporation?

An S Corporation (S Corp) is a special type of corporation that allows business owners to avoid double taxation. Income is passed through to shareholders and taxed only at the individual level, not at the corporate level. This business structure blends aspects of both corporations and partnerships, providing flexibility and tax benefits.

How an S Corp Differs from Other Business Structures (C Corp, LLC)

• C Corporation (C Corp): Unlike S Corps, C Corps are subject to double taxation. The company pays corporate taxes on profits, and shareholders pay personal taxes on dividends received. C Corps also has no limit on the number of shareholders or ownership restrictions.
• Limited Liability Company (LLC): LLCs provide personal liability protection and flexibility in taxation (it can be taxed as a sole proprietorship, partnership, or corporation). LLCs do not face the strict ownership and shareholder restrictions of S Corps, but S Corps offers more structured tax savings for owners.

Advantages of Electing S Corp Status for Tax Purposes

• Pass-Through Taxation: Profits and losses are passed through to shareholders and reported on their tax returns, avoiding corporate-level taxation.
• Reduced Self-Employment Taxes: S Corp shareholders can be company employees and take a reasonable salary, only paying self-employment taxes (Social Security and Medicare) on that salary. Any additional income (distributed as dividends) isn’t subject to self-employment tax, resulting in potential tax savings.
• Limited Liability: Like other corporations, S Corp shareholders enjoy personal liability protection, meaning their assets are shielded from company debts and legal obligations.
• Business Continuity: S Corps offers greater business continuity than sole proprietorships and partnerships, as the business entity remains intact even if ownership changes.

Eligibility Requirements for Forming an S Corp

• Domestic Corporation: The company must be a U.S.-based corporation or LLC.
• Limited Shareholders: The company can have no more than 100 shareholders.
• Qualified Shareholders: Shareholders must be U.S. citizens or permanent residents. Certain trusts, estates, and tax-exempt organizations are allowed, but partnerships and corporations cannot be shareholders.
• One Class of Stock: S Corps can only issue one class of stock, though differences in voting rights are allowed.

How S Corp Taxation Works

S Corporations (S Corps) benefit from pass-through taxation, meaning the business does not pay federal income taxes. Instead, profits and losses “pass-through” to the shareholders, who report them on their tax returns. This allows S Corp owners to avoid the double taxation faced by C Corporations, where the company pays taxes at the corporate level, and shareholders pay taxes again on dividends.

Description of Pass-Through Taxation

Pass-through taxation is a major advantage for S Corps. All business income, deductions, credits, and losses are passed directly to shareholders. Instead of paying corporate taxes, the company’s financial results are divided among its shareholders according to their ownership percentage. These figures are then reported on each shareholder’s tax return, and they are taxed at their income tax rate.

How Profits and Losses Are Reported on Shareholders’ Tax Returns

S Corp shareholders report their share of the company’s profits or losses on Schedule K-1, which is issued annually. The K-1 outlines each shareholder’s portion of the S Corp’s income, deductions, and credits. Shareholders include these amounts on their tax returns (Form 1040), which impacts their taxable income. Even if no cash distribution is made, shareholders must still pay taxes on their share of the S Corp’s earnings.

The Impact of Self-Employment Taxes on S Corp Owners

One of the biggest tax benefits of an S Corp is its potential to reduce self-employment taxes. Shareholders who work for the S Corp can receive two types of income:

• Salary: S Corp owners must pay themselves a “reasonable salary” for their work, subject to self-employment taxes (Social Security and Medicare).
• Distributions: Any remaining profit that is not subject to self-employment tax can be distributed. This results in significant savings compared to sole proprietorships and partnerships, where all earnings are subject to self-employment taxes.

This structure allows S Corp owners to balance tax efficiency with IRS compliance, ensuring they pay their fair share of employment taxes while benefiting from the tax-advantaged distribution of business profits.

The 10 Strategies

1. Reduce the S Corporation Owner’s Wages

As an S corp owner, you’re likely wearing two hats: shareholder and employee. One simple but effective way to reduce your tax bill is by adjusting the wages you pay yourself. When you reduce your salary, you decrease the payroll taxes you owe—Social Security and Medicare tax, for example. Instead, you can distribute profits as dividends, not subject to these payroll taxes.

However, be cautious. The IRS requires you to pay yourself a “reasonable” salary for your work. If your salary seems too low for your role, it could trigger an audit. Therefore, ensure your wage reduction aligns with industry standards and your actual contribution to the business.

2. Deduct the S Corporation Owner’s Health Insurance Premiums

Health insurance premiums can add up quickly, but here’s the good news: you can deduct them as an S corp owner. If your S corp pays your health insurance premiums, these amounts can be deducted as an “above-the-line” deduction on your tax return.

To qualify, the policy must be in the company’s name or reimbursed by the S corporation. This strategy reduces taxable income and decreases the self-employment tax burden.

3. Employ Your Child to Lower Your Taxable Income

Employing your children is a brilliant way to lower your S corp’s taxable income while keeping the money in the family. The wages paid to your child are deductible for your corporation, and if your child is under 18, you don’t have to pay Social Security or Medicare taxes on their wages. Plus, they likely won’t owe any taxes on the income if it’s below the standard deduction amount.

This strategy allows you to shift income from the higher tax bracket you’re likely to be in into your child’s lower (or zero) tax bracket, creating a win-win situation.

4. Sell Your Home to Your Corporation Before Converting It to a Rental Property

If you own property that you’re thinking about renting, consider selling it to your S corporation before making the conversion. This lets you turn part of your home into a legitimate business asset. Your corporation can then depreciate the property and deduct rental expenses, such as repairs, insurance, and property taxes.

Selling your home to your business may also enable you to realize a capital gain exclusion on the sale (up to $250,000 if single, $500,000 if married), provided you meet the primary residence ownership rules.

5. Establish a Home Office and Reimburse Yourself for the Expenses

Your S corp can reimburse you for home office expenses by setting up a qualified home office. This includes a portion of your rent or mortgage, utilities, and other household expenses that directly relate to the business use of your home.

This tax-free reimbursement lowers your corporation’s taxable income, killing two birds with one stone. Remember, for this strategy to work, the home office must be your principal place of business or where you regularly conduct significant business activities.

6. Rent Your Home to the S Corporation for 14 Days or Less

One of the easiest ways to lower your taxable income is to rent your home to your S corporation for 14 days or less per year. Under IRS rules, rental income earned from your home for fewer than 15 days is tax-free.

If you hold company meetings or events at home, your S corp can pay you a fair rental rate. The corporation deducts the rental expense, and you can pocket the income tax-free. Just document the rental purpose and fair market rental value to avoid scrutiny.

7. Reimburse the Owner for Depreciation Expenses on Business Use of Vehicle and Home Office

If you use your personal vehicle or home office for business, your S corporation can reimburse you for depreciation. This is a great way to recoup costs without triggering additional taxable income. Depreciation deductions for vehicles and home offices can be taken, providing a significant tax benefit.

To maximize this deduction, ensure you maintain proper business use records. The percentage of the vehicle or home office used for business will determine how much depreciation you can claim.

8. Combine the Home Office with a Heavy SUV or Pickup Truck for Big Deductions

If your S corp needs a vehicle, consider purchasing a heavy SUV, crossover, or pickup truck weighing over 6,000 pounds. The IRS allows accelerated depreciation for these vehicles under Section 179, meaning you can deduct a substantial portion of the vehicle’s cost in the year of purchase.

Pair this with a home office deduction; you could potentially deduct thousands in one tax year. This is especially useful if you have a large taxable income and want to reduce it before the year ends.

9. Reimburse the S Corporation for Travel Expenses

If you travel for business, your S corporation can reimburse you for these expenses, reducing the company’s taxable income. This includes transportation, lodging, meals, and even incidental expenses like tips and parking fees.

To ensure compliance, keep thorough records and receipts. Reimburse travel only directly related to your S corporation’s business activities.

10. Deduct Your Smartphone and Provide Smartphones as Fringe Benefits

Your smartphone is likely an indispensable part of your business operations, so why not make it work for you come tax time? Your S corporation can deduct the cost if your phone and monthly service plan are primarily used for business. You can also provide smartphones to your employees as a tax-free fringe benefit, boosting productivity while saving on taxes.

To qualify, the phone must be necessary for your business operations, and you should maintain records showing its business use.

Final Thoughts

The time is coming to make the most of these S corp tax strategies. By implementing them before the end of the year, you can significantly reduce your tax bill while staying compliant with IRS regulations. Be sure to consult with a tax professional to ensure each strategy is applied correctly and to make the most of the deductions available to your business.

Act now, and ensure you enter the new year with a stronger financial footing!